Micro Exam 3 Study Guide PDF

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Amit Rubinstein Micro Exam 3 Study Guide Chapter 13 – Perfect Competition Characteristics of a Competitive Market – Competitive Market  A market in which fully informed, price-taking buyers and sellers easily trade a standardized good/service  Free entry + exit into the market – Price Taker  A buyer/seller who cannot affect the market price  So many buyers/sellers  can’t set own price – Market Power  The ability to noticeably affect market prices. – Standardized goods  Goods that are interchangeable  Commodities: natural resources (e.g. oil, gold, etc.) – type of standardized good  No info asymmetries – everyone know exactly what they’re trading – Free entry and exit  Firms must be able to freely enter/exit market  competition Revenues in a Perfectly Competitive Market – Producers are able to sell as much as they want without affecting the market price  Don’t have to worry about influencing price or finding buyers  Wont produce infinitely  increasing MC  increasing costs mean decreasing profits since price is constant!  Market price won’t change because one firm doesn’t have a huge impact on the entire market. – Average revenue  (Total Revenue) / (Quantity sold)  same as price of the good – Marginal Revenue  Revenue generated by selling an additional unit of a good = price of a good.  Same as average revenue in a perfectly competitive market! Profits and Production Decisions Deciding How Much to Produce – A firm should keep producing as long as MC < MR and stop when MC = MR  profit-maximizing quantity – Figure 13-1 Page 291  In a perfectly competitive market, MR = a straight line (selling at same price) Deciding When to Operate – MC intersects both AVC and ATC at their lowest points (profit continues to increase until MC>MR, so AVC and ATC will continue to go down until that point of intersection) – (Total costs) – (Variable costs) = fixed costs – Fixed costs in short run = sunk costs  irrelevant in deciding whether to shut down in the short run.

– Shutting down in short run depends on VC of production – If AVC < market price < ATC  production should continue in short-run.  Lose less than you would if you stopped production altogether  Loss-minimizing level of production: point at which market price intersects MC curve.  Ideally will produce up to the point where P (or MR) = MC – If P < AVC (the cost of increasing production!)  should shut down  Figure 13-2 page 293 – In the long-run, everything becomes a VC  Exit of P ATC  more firms enter the market – ATC includes OC  Therefore a firm will stop what it’s doing and join market or leave if it has better opportunities elsewhere  Increasing supply  supply curve shifts right + constant demand = lower price and higher quantity. VV – 3 characteristics of a perfectly competitive market in the long-run:  Economic profits = 0 (could not make more money by operating else where) – Account profit =/= 0 – The firm is already maximizing accounting profits – Could still generate an accounting profit below ATC, but could make more doing something else.  Firms operate at an efficient scale (minimizing ATC – forced to because of competition, firms stop entering/exiting) – P=MR=MC; MC=ATC (at minimum of ATC)  P=ATC  Supply is perfectly elastic (horizontal) – P must = ATC – Positive/negative profits  firms enter/exit  quantity will increase/decrease until price returns to the point where economic profit = 0. Why the Long-run Market Supply Curve Shouldn’t Slope Upward, But Does – Price has to go up for quantity to increase (for firms to enter the market) – In reality:  Price = minimum ATC for the least efficient firm, other firms are able to earn positive economic profit  A new firm will not have the same efficiency as a firm that has already been in the market. Therefore, new firms need to be enticed in order to join the market.

– Improved production efficiency  ATC, MC curves move down  minimum ATC drops below market price  higher profits  more room for firms to join  firms join  more supply  lower prices Responding to Shifts in Demand – Figure 13-8 page 300 – If demand increases  short-run supply increases (more firm enter)  quantity increases again, lowering price back to long-run equilibrium. Chapter 14 – Monopolies Why Do Monopolies Exist? – Monopoly  A firm that is the only producer of a good/service with no close substitutes  Ex: No close substitute  monopoly on water is very lucrative, orange juice is not because people will go to other juices if the price is too high. Barriers to Entry – 4 main barriers to entry:  Scarce Resources  Economies of Scale – Competition doesn’t make sense, infrastructure too expensive – Natural monopoly  A market in which a single firm can produce, at a lower cost than multiple firms, the entire quantity of output demanded.  Governments often get involved to avoid abuse of monopolistic power  Government intervention – Can create/sustain monopolies where they would otherwise not occur. – State-owned monopolies through prohibition of competition or heavy subsidies – Private monopolies through patents + copyrights  Aggressive Tactics – Tactics to gain monopolistic power – E.g. Predatory pricing – large company suffers short-term losses due to low prices in order to make smaller companies go out of business. How Monopolies Work Monopolists and the Demand Curve – Can charge any price but the higher the price, the lower demand is – Most focus on shifting curve to the right in order to sell a higher quantity at a higher price. Monopoly Revenue – Producing an additional unit drives down price. – 2 effects of producing more:  Quantity effect: additional sale  revenue increases  Price effect: Additional sale  selling price goes down  revenue goes down – Total revenue will increase/decrease depending on which effect is larger – Because of price effect, marginal revenue for a monopoly is always less than the selling price.

– Figure 14-2 page 317  Average revenue = price at any quantity sold (only one seller, one price) = Market demand  Marginal revenue always below AR because of the price effect, negative when price effect > quantity effect – MR crosses the x-axis (0 marginal revenue) at the revenue-maximizing quantity. Maximizing Profits by Picking Price and Quantity Sold – Figure 14-3 pg. 318 – Maximizing quantity = where MC=MR – One difference with monopolies: Price > MR (because of price effect)  P>MC at optimal production (not losing money so MR>MC)  profit-maximizing price is the price on the demand curve that corresponds to the profit-maximizing quantity of output. – Because other firms can’t enter the market and drive the price down  Profit = (P – ATC) * Quantity  If price > ATC  Profit  Figure 14-4 page 320 Problems with Monopoly and Public Policy Solutions The Welfare Costs of Monopoly – Figure 14-5 Page 321  In a perfectly competitive market, total surplus is maximized. Market is producing past MC=MR, where P=MC.  In a monopoly, quantity is where MC=MR  deadweight loss, more producer surplus > consumer surplus. Public Policy Responses – Antitrust Laws  “Trusts” = massive corporations with a lot of economic power  Sherman Antitrust Act: fucked shit up and broke up many monopolies – still has an impact today.  Clayton Antitrust Act: Stop monopolies from forming in the first place – Blocks mergers if they would lead to monopolies  Antitrust action can cause deficiencies – Break up natural monopolies – Break up a large company into several firm that operate at a smaller-thanefficient scale – Public Ownership  Natural monopolies can still try to exploit the public  Public ownership of natural monopolies  government serves public interest rather than maximizing profits  Figure 14-6 Page 325 – In natural monopoly: ATC falls as quantity increases  MC below ATC – If set price at P=MC  losses because ATC is more.  Doesn’t happen. – In a regulated (price ceiling) natural monopoly: price ceiling lowers price to a point where deadweight loss is reduced (although not completely gone) while still making a profit.

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Problems with public ownership: – Politicians feel pressure to lower prices past competitive price  shortages due to higher demand – Company decisions based off of political concerns – Loss of motivation since not aiming to make a profit  could just cover losses with taxes  These concerns are why many public ownerships have been privatized regulation is often favorable. – Regulation  Price regulation  However, not so easy to set the right amount – Private firms don’t want to be completely transparent with the government (to avoid stricter regulations) – Government doesn’t want to hinder firm’s motivation to receive a profit. – Too low  firm goes out of business – Vertical Splits  Horizontal split = dividing a firm into several firms that compete to sell the same product  Vertical split = divide original firm into companies that operate at different points in the production process. – E.g. splitting generation + supply of electricity – firms compete to generate, one supplies – No Response  Sometimes intervention could be worse if not properly handled Market Power and Price Discrimination What is Price Discrimination? – Price Discrimination  The practice of charging customers different prices for the same good.  Becomes more doable with more economic power. – Discriminate between customers based on their willingness to pay. – E.g. College ID for discounts – different price for same good. – Impossible in a perfectly competitive market.  Firms sell at P=ATC  Zero economic profit  lower price  negative profit.  Charging non-students more  customers go to competition – Perfect Price Discrimination  When a company can meet each consumer’s demand perfectly at every price.  Rarely happens, companies can satisfy a good amount however.  At perfect discrimination the market is at full efficiency – Full efficiency doesn’t mean surplus is equally distributed Price Discrimination in the Real World – Need a way to define categories of customers  E.g. Need to show college ID – Need to make sure the system isn’t exploited. Chapter 15 – Monopolistic Competition and Oligopoly

What Sort of Market? Oligopoly and Monopolistic Competition – Oligopoly  A market with only a few firms, which sell a similar good/service – Good/service not completely standardized but similar – Strategic interactions between firms = vital  Price + quantity set by an individual firm affects the others’ profits. – Some barriers to entry – Monopolistic Competition  A market with many firms that sell goods and services that are similar, but slightly different  Firms have a “limited” monopoly  E.g. Elvis records only sold by Sun  Products have substitutes that are close but not perfect  can set slightly higher prices, but too high and consumers will go to substitutes – Oligopoly is about the # of firms – Monopolistic competition is about variety of products Monopolistic Competition – Production Differentiation  The creation of products that are similar to competitors’ products but more attractive in some ways.  How monopolistically competitive firms make a profit. Monopolistic Competition in the Short-Run – Product differentiation  firm is like a monopoly in the short-run – Figure 15-2 page 341  Down-ward sloping demand curve  U-Shaped ATC curve  Profit-maximizing production quantity: where MR=MC Monopolistic Competition in the Long Run – Main difference between monopolistically competitive firms + monopolies: other firms can enter a monopolistically competitive market. – Other firms can produce more similar substitutes  E.g. Apple iPad  bunch of tablets from other companies  Curve shifts left (demand for original product decreases) – Firms continue to enter as long as firms in the market continue to make profits. – Stop entering when firms stop making a profit – If losing money in short-run  firms exit  demand increases  firms stop exiting when break even. – In the long-run, perfectly competitive firms + monopolistically competitive firms face situations where profits are driven down to zero (revenue = cost)  Profit-maximizing quantity: ATC = Price (figure 15-3, 15-4, page 343-344) – Where ATC is tangent with price (MR = MC) – Could lower ATC more but would reduce profits  producing at smaller-thanefficient scale – Zero revenue means companies aren’t entering/exiting  If ATC is not exactly tangent  profits are positive/negative

– Because monopolistically competitive firms have profits driven down to 0 and a downward sloping demand curve:  Operate at a smaller-than-efficient scale – Firm has excess capacity  Want to sell more – If can sell more at same price  profit; Monopoly  sell more  price goes down; perfect competitive  need to lower price to sell more. – The need for continual innovation  To counter closer substitutes from entering firms. The Welfare Costs of Monopolistic Competition – Monopolistic competition is inefficient  Deviation from equilibrium price + quantity – Very difficult to regulate since many firms + slightly different products. – Could set single price  competition  since at 0 profit, firms that couldn’t produce at lower cost exit  lower price, more quantity, but less variety. – Not a huge impact on welfare, regulation may not be appreciated by consumers  regulation not very common. Product Differentiation, Advertising, and Branding – Monopolistically competitive firms need to either innovate and create truly different products or convince customers their product is different (advertising) – Advertising can have 2 effects:  Information  competition  lower price  Mislead  consumers less willing to go to substitutes (less competition)  higher prices – Can get an indication of which effect is greater based on producers’ reactions in the face of advertisement bans  If against bans – advertisements probably mislead (firms want less competition)  If silent/supportive – advertisements inform (firms want less competition through less info) – Advertising As a Signal  Consumers can use the cost of ads (not content) as a signal to gauge the quality of a product/service  If firm invests a lot in ads for product/service  confident in its success  consumers can interpret that as a sign the product is truly of high quality. – Branding  Strong brand = high reputation  high quality product  But, strong brands could also perpetuate false perceptions of quantity or product differences – E.g. more expensive, name brand medicine vs. generic – Can form a barrier to entry  Oligopoly Oligopoly Oligopolies in Competition – Oligopolies could agree to act as a single monopoly and thereby control quantity to maximize profits – But if a firm decides to try to increase its own profits by increasing quantity, it would lower profits for other firms  retaliation  competition

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Competition between oligopolists  lower prices + profits below monopoly level.  However, prices wouldn’t necessarily go down to the efficient level. – 2 effects of production:  Quantity effect (more quantity  higher profit)  Price effect (more quantity  lower price  lower profit) – If quantity effect > price effect  profit-maximizing firms will increase output. VV – Price effect is smaller with more firms – Main idea: An oligopolist’s production decision affects the profits of other firms as well.  Profit-raising effect: felt only by the firm changing production.  Profit-lowering effect: Felt by other firms – A decision that is profit-maximizing for an individual firm lowers combined profits for the market as a whole. Compete or Collude? – Oligopolists face the prisoner’s dilemma  Join to act as a monopoly or compete? – Collusion  The act of working together to make decisions about price and quantity – If both collude they would be better off than both competing. But each would have the incentive to compete in order to make more – Dominant Strategy  A strategy that is the best one for a player to follow no matter what strategy other players choose – Nash equilibrium  An equilibrium reached when all players choose the best strategy they can, given the choices of all other players  Nobody will have an incentive to break equilibrium at this point. – Choosing a strategy is a “repeated” game – firms will compete year after year  consider future profits  incentives change  may be more willing to collude. – Cartel  A number of firms who collude to make collective production decisions about quantities or prices.  Usually illegal Oligopoly and Public Policy – Oligopolies  deadweight loss – Competitive Oligopolies are in between perfect competitions and monopolies – Collusion oligopoly = Monopoly – Figure 15-8, page 357 Chapter 16 – Factors of Production: Land, Labor, Capital – Factors of Production  The ingredients that go into making a good/service  Labor, land, capital – Labor = time employees spend working

– Land = place where employees work – Capital = manufactured goods that are used to produce new goods Derived Demand – Demand for a factor of production that occurs as a result of the demand for a final good. – Ex: Demand for tomatoes increases  farmers’ demand for pickers, irrigation equipment, etc. increases Marginal Productivity – Marginal Product  The increase in output that is generated by an additional unit of input.  Equal to the slope of the total production curve (figure 6-1, page 368)  Diminishing returns Picking the Right Combination of Inputs – Firms seek the profit-maximizing combination of inputs – Ex: Machinery is more expensive in poorer countries  poor countries = laborintensive, rich countries = capital (machinery) intensive Labor Markets and Wages Demand for Labor – Value of the marginal product (AKA marginal revenue product)  (marginal product)*(price of output)  The additional revenue from increasing labor – Competitive firms should continue hiring until VMP >= MC – VMP curve = demand curve for labor (Figure 16-2 page 371)  Makes sense, since diminishing returns on MP, VPM will diminish too since getting less returns on each input and therefore less value. Ultimately, there is a direct correlation between the demand for labor and VPM. Supply of Labor – Supply depends on OC to workers – Higher wages  Benefits of working increase, OC of working become less significant – More supply of labor as wages go up. – The price and income effects  Higher wages also increase OC of working – Leisure time is more enjoyable when you have more money. – Higher wages  employees decide to work fewer hours  reduced labor supply.  Price effect = higher wages  increase in labor supply  Income effect = higher wages  more enjoyable leisure  decrease in labor supply  Figure 16-4, page 374 – The effect of increased wages on labor supply depends on which effect dominates – If the price effect dominates  upward sloping labor supply curve. VV. (wages vs. hours) – The price effect usually dominates in real life. Reaching Equilibrium

– Equilibrium is where demand and supply cross. – Works like any demand and supply graph – Wages above equilibrium  surplus of supply. VV. Shifts in Supply and Demand – A shift in one curve may prompt a shift in another. – Ex: Fewer workers  supply shits left  rather than lowering wages, firms may opt to increase capital (decreasing the demand for labor). Determinants of Labor Demand and Supply – Determinants of labor demand  Supply of other factors – Ex: Supply of gas decreases  price of gas increases  Price of using machinery increases  Demand for manual labor increases  Technology – Often labor-augmenting: increases marginal product of labor (i.e. each worker is more productive)  demand for labor increases – Can also be labor-saving: reduced marginal product of labor  demand for labor decreases.  Output Prices – Price of final product decreases  VPM decreases  demand for labor decreases – Determinants of labor supply  Population: More workers  more supply  Culture: Positive cultural attitude towards working  more supply  Other opportunities: The next-best opportunities can increase/decrease supply. – Ex: Better wages + conditions in retail  decreased supply of labor in agriculture. What’s Missing? Human Capital – Human Capit...